temper you enthusiasm

Firstly let me preface this post by saying I really like the business and for the right price I'd like to own it for it's growth prospects. However, I cannot justify purchasing at the current price.

At present this is not a profitable business. Yes, it has phenomenal growth rates and potential, but until it becomes profitable and its potential is reached it should be discounted for that risk.


-Cashflow
In the quarter ended 30-Jun XRO had net cash outflows of $9m. Annualised this equates to $36m. CASH AT 30-JUN was $69m, assuming a constant cash spend for the remainder of the FY (31-Mar) cash at year end would be $42m. Management have forecast a greater loss in FY14 than FY13 so the company is unlikely to suddenly move to profitability or become cashflow positive in FY15, therefore there is a high likelihood of a capital raising in late FY15 or early FY16. Current shareholders should factor in some sort of dilution in their forecasts.

-Growth
102% revenue growth in FY13, only 80% forecast for FY14. Still amazing growth but long-term these early startup growth rates are not sustainable growth rates. Its easier to achieve amazing growth rates of a low base but now they have a significant number of clients (200k), it's not going to be easy to achieve the same growth rate (ie: to keep up the same growth rate for the next 6 years would mean a customer base of 12,800,000 (200,000*2^6). This sort of customer base is beyond 100% of the AUS and NZ market so growth is reliant on the much bigger U.S and UK markets which as yet they have no proven success in. - On the off-chance those growth rates were achieved the increase in infrastructure and staff numbers would be a challenge to manage (not to say they can't do it, but many companies with great prospects.products have failed due to this and not due to demand for their product).

- Back of envelope profitability calc
Assuming XRO can manage a net margin of 20% (which is better than Intuits ~18-19%) and a P/E of 25 (fairly generous), XRO would need sales of $363,375,000 to justify it's current price. That's an increase of 931%!!!! on current revenue of $39,033,000.

Current Price = $15.58
Shares on issue: 117,219,000

$363,375,000(sales) * 20% = $72,675,000 (profit)
$72,675,000(profit)/117,219,000(shares) = 0.62/share
$0.62 * 25(P/E multiple) = $15.5 (current price)

Assuming XRO can achieve the forecast FY14 revenue growth rate of 80% (which would be an amazing achievement) it would take around around 3.8 years to reach the required sales which would justify todays price based on my assumptions and valuation metrics. If that compounded annual growth rate were to drop to 60% it would take around 4.8 years.

My point being, the company is being valued as though it's made it already. It's not there yet. There's significant risks. Even if it does make it, it's still not that cheap. I love growth stocks, but if I'm going to take a punt on a stock that hasn't ever turned a profit I need a better prospective return.

Interestingly this little exercise has turned me on to RKN. It's certainly not as sexy or as in vogue as xro but it's valuation reflects that. I'll probably post a report on it's forum soon also.